An annuity is a type of insurance service. In general terms, in an annuity contract, an insurance company and an annuitant contract for the annuitant to make one or more payments to the insurance company. For that consideration, the insurance company makes periodic payments to an annuitant. By way of example, the insurance company may be obliged to make a payment of a predetermined amount to the annuitant annually for a predetermined time period. In another example, the insurance company is obliged to make payments of a predetermined amount to the annuitant annually for the life of the annuitant.
Annuities may be immediate annuities, in which the stream of payments begins immediately upon purchase of the annuity contract. Annuities may also have a deferral period, in which the stream of payments only begins after expiration of the deferral period. The asset value of an annuity upon the commencement of a stream of payments generally is a significant factor in determining the amount of the payments. During the deferral period, the insurance company may credit the account with interest. An account bearing a fixed rate of interest provides predictable gains. However, over almost all periods of more than a few years since 1945, stock market indices at least in the United States have generally provided better investment returns than fixed-interest assets.
In a variable annuity, the asset value is determined by changes in values of one or more securities funds. In a variable annuity, the annuitant may select a fund from a menu of funds that the insurance company makes available. The funds are managed by a third party investment adviser, and not the insurance company. The investment adviser receives compensation for its services in the form of a management fee. The management fee is generally based on a percentage of the asset value of the account invested in the fund. The management fee amount is generally quoted to the annuitant on an annual basis, although it may be assessed, by a deduction from the net asset value of the account, on the basis of a business day. The insurance company collects the deduction from the net asset value of the account, and pays the investment adviser from that deduction.